Modi at the helm, and the rupee…falls

The Indian rupee has plunged almost 5 percent against the greenback since pro-business Prime Minister Narendra Modi swept to power in May – so what's behind the currency's fall and where is it headed next?

Foreign exchange strategists point to a confluence of factors behind the currency's recent weakness starting with skepticism over theModi-led Bharatiya Janata Party (BJP) government's resolve to usher in economic reforms.

"The market is disappointed with the recent budget and a lack of fresh initiates from the new government," Nizam Idris, head of strategy, fixed income and currencies at Macquarie told CNBC.

Since the election, there has been closer scrutiny on the nature and pace of reforms to boost long-term growth and curb inflation in Asia's third largest economy.

Modi's maiden budget, delivered in July, failed to live up to the market's high expectations of big bang reforms. Analysts described it as a step in the right direction, but critiqued it for being short of specifics on a number of key issues, in particular how it plans to achieve a fiscal deficit target of 4.1 percent of gross domestic product (GDP) for the financial year 2014-2015, from 4.5 percent in the previous year.

The rupee traded around 61.10 per U.S. dollar on Monday, far off the year's high of 58.23 hit on May 22 - days after the general elections concluded on May 16.

An increase inrisk aversion due to a recent flare up in geopolitical tensions and uncertainty over when the Federal Reserve will begin tightening monetary policy, has also contributed to the currency's fall.

"The rupee is still a currency that's sensitive to risk aversion. After all India still runs a current account deficit," said Mitul Kotecha, head of FX strategy for Asia-Pacific at Barclays.

While the deficit has narrowed considerably to 1.9 percent of GDP, this feature still implies that the rupee is relatively more exposed to the volatility of capital flows than most other Asian currencies.

Limited downside

Weakness in the rupee is likely to be contained, say strategists, adding that new reform announcements by the government would likely get the currency's rally back on track.

"I'm still optimistic we'll get clarity on the reform agenda in the months ahead," said Idris, who sees the rupee ending the year closer to 60.

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"By December, we'll get details on the government's fiscal consolidation plan – including the implementation of the goods and services tax (GST) – and that could renew optimism," he said.

Kotecha agreed, adding that on top of new reform announcements, so long as there are no renewed bouts of risk aversion, the currency will renew its appreciation trend in the coming months.

"The rupee's recent decline is more of a pause more for breath. The positive sentiment hasn't been derailed yet. More announcements on measures to open up the economy will see the rally back on track," said Kotecha, who forecasts the rupee will rise to 59 by year-end.